This article was written by Zuora CEO and Founder Tien Tzuo and originally published at Marketwatch.com.
Investors should watch how executives address ASC 606 in third-quarter earnings.
Uber’s reported revenue is being cut in half. IBM plans to spend an unexpected $35 million-40 million. And General Motors might have to reduce its balance of earnings by $1 billion next year. Why?
New accounting standards ASC 606 and IFRS 15 will force companies to completely re-evaluate when and how they account for their revenue. Right now, thousands of accountants are scouring through old contracts to determine whether their sales need to be booked differently.
After 12 years of work, the Financial Accounting Standards Board (FASB) and their international counterpart the International Accounting Standards Board (IASB) issued new standards for recognizing revenue from contracts with customers in 2014. The goal was to simplify and harmonize revenue recognition practices globally. The new standards are based on one overarching principle: “Companies must recognize revenue when goods and services are transferred to the customer, in an amount that is proportionate to what has been delivered at that point.”
But for those that don’t put in the work now, misappropriation of standards might cause revenue recognition errors. These errors are the No. 1 reason for restatements, which history shows us can lead to firings, stock-price drops, jail time and a tarnished reputation.
If you’ve been in Silicon Valley as long as I have, you might remember when the CEO and CFO of CA Technologies went to jail for falsely reporting $2 billion of revenue in 1999 when numerous license agreements were finalized after reporting periods had closed.
“With the FASB ASC 606 accounting rules, we get lunatic things like software companies recognizing term licenses upfront despite not getting the cash. This is what Enron did and, as I recall, that episode didn’t work out super well for anyone,” said Richard Davis, an analyst at Canaccord Genuity.
With ASC 606, might we see more of this in 2018? I think so.
But don’t take my word for it. Here’s what a finance executive, an accountant, a hedge-fund manager and a management consultant have to say about it:
If you had one prediction to make after the standard goes into effect, what would it be?
Are most investors blind to the potential effect of ASC 606? Why should they care?
Now that you know why everybody is suddenly talking about accounting, the question is what will you do about it? If you’re a C-Suite executive and your company doesn’t yet have a plan to put in the work to deal with these changes, it’s time to wake up. And if you’re an investor who doesn’t know how your companies are handling this change, make sure you pay extra attention to third-quarter earnings reports for guidance on how they will adopt the standards before the January deadline.
Tien Tzuo is CEO and founder of Zuora, a provider for software for CFOs.